JPMorgan AGM punctured by thorny hedge issues

May 17, 2012

By Christopher Elias

LONDON/NEW YORK, May 17 (Business Law Currents) – JPMorgan’s disastrous $2 billion hedge loss has raised some thorny issues on management oversight, corporate governance and the effectiveness of the Volcker Rule, as division at the banking giant’s annual general meeting highlight a growing tension between its shareholders and management.

Little more than a week ago, prior to Tuesday’s annual general meeting (AGM), JPMorgan announced that it had incurred a $2 billion loss as a result of a hedge gone wrong from its London offices with the possibility of $1 billion in additional losses to follow.The exact nature of JPMorgan’s derivative betting and what went wrong remain remarkably vague, despite JPMorgan’s numerous public statements. While the prevalent theory being made by financial analysts is that this was a “flattener” bet or a directional bet on credit default indices, the consensus that for the hedge to have generated $2 billion in losses, its unwinding was likely as disastrous, if not more so, than the “hedge” itself.

The fallout from this baneful bet became a comedy of errors after JPMorgan CEO Jamie Dimon described the matter as a “tempest in a teapot”. Dimon was later forced to admit at a hastily convened conference call that the “new strategy was flawed, complex, poorly reviewed, poorly executed, and poorly monitored.”

With management desperately trying to plug a hole in the balance sheet, questions are being raised about the competency of JPMorgan’s management and how corporate governance and risk procedures could have allowed such a volatile and ultimately disastrous investment to have manifested itself.

Age-old shareholder concerns over the dangers of one person holding the combined role of CEO and Chairman, and of the effectiveness of management oversight, surfaced and made for a tense AGM. Despite the discord, JPMorgan’s executive team remained largely intact, with the exception of chief investment officer Ina Drew, the lone casualty – having retired shortly before the start of meeting.

The matter has highlighted persistent corporate governance issues at large banks that look increasingly “too big to manage” as well as “too big to fail”.

Dodd-Frank requires major financial institutions ensure that that senior executives are involved in risk management and requires the establishment of a risk management committee to oversee a bank’s activities.

The Federal Reserve had proposed rules to require at least one member of the committee to be a risk management expert, but the rules remain unfinalised. Serious concerns were raised last year by CTW Investment Group, a JPMorgan shareholder, that JPMorgan’s present three-person risk policy committee fails to contain a single expert in banking or financial regulation.

According to CTW Investment Group, the present committee consists of David Cote, CEO of Honeywell International, James Crown, president of Henry Crown & Co, a privately owned investment company, and Ellen Futter, president of the American Museum of Natural History. CTW also noted that Ms Futter’s tenures at Bristol-Myers Squibb and AIG coincided with significant governance and risk-management failures.

Further concerns over risk management have been raised by JPMorgan’s continuing use of a joint CEO and Chairman position. The pension fund for American Federation of State, County and Municipal Employees (AFSCME) tabled a motion at the AGM for the bank to separate the roles in order to provide a proper system of checks and balances.

Receiving support from proxy advisers ISS and Glass Lewis, the non-binding proposal received around 40 percent of votes cast but was ultimately unsuccessful. Despite its failure, the extraordinarily high level of support is a warning sign for JPMorgan that a large proportion of its shareholders are unhappy with the current state of affairs. ISS and Glass Lewis also noted publically that companies with a joint CEO and Chairman are frequently outperformed by their rivals.

Alongside corporate governance apprehensions, the losses have created concern regarding the Volcker rule and its effectiveness to restrain the risky bets of banks. As part of the Dodd-Frank financial reform, the Volcker rule is supposed to prohibit the proprietary trading by commercial banks but permits banks to using “hedging” as a way to control risk.

The ability of JPMorgan’s “hedge” to generate such large levels of loss supposedly not offset by some equivalent exposure has raised the question of whether such a position would have been permitted under the Volcker rule. Characterised as a “hedge” by JPMorgan, it presumably would have been permitted when the Volcker rules enters force, somewhat questioning the efficacy of the rule in restricting the risky bets of banks.

The matter has also shone a light on what is considered a “hedge” and how these positions can look remarkably similar to proprietary trading. Seemingly permitting derivatives on synthetic indices with no obvious correlating exposure, the hedge was at best an insurance against general exposure, and at worst a money making exercise.

According to a Reuters report featuring insight from traders at other firms, the losses were likely as a result of bets tied to debt through an index known as CDX.NA.IG.9, which tracks credit default swaps on about 127 investment grade companies in North America, including Target, Home Depot, Kraft Foods, Wal-Mart and Verizon Communications.

The position built up into layers of index positions that were both for and against corporate creditworthiness deteriorating. Some of the positions were supposed to offset, or neutralize, one another but as more layers were added the risk that these would not offset each other materially increased.

Whilst possibly within the letter of the Volcker rule, such a complex and precarious hedge would seem to defy its spirit. Based on a synthetic index and trading the differences between tranches, its purpose as a hedge seems remote at best. The fact that JPMorgan, widely believed to be one of the best run banks on Wall Street, failed to appreciate the risks of the trade only underlines the significance of the Volcker rule. It perhaps also highlights the difficulties for regulators in understanding the challenges that still lie ahead.


(This article was initially published by Thomson Reuters’ Business Law Currents, a leading provider of legal analysis and news on governance, transactions and legal risk. Visit Business Law Currents online at

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